1. Technical Field
The present invention relates to a method of, and system for, enabling companies issuing both equity and debt, and governments and government agencies issuing debt, to exercise the rights they possess as issuers of equity and debt in order to manage and optimize the utility and value of their offerings and holdings in the global financial marketplace.
2. Brief Description of the Prior Art
In conventional securities issuance, as set forth in FIG. 1 of the Drawings, the issuing company or government enlists the aid of an investment bank in order, first, to structure the equity or debt offering and second, to underwrite/distribute the offering to purchasers. The investment bank then returns the proceeds, less applicable fees, from the equity/debt sale to the issuing company or government.
Issuers of equity and debt have many options from which to choose when trying to raise money. Typically, a company can issue common or preferred stock (equity), or a company or government can issue different types of debt, with the primary differentiators being the terms (contract) under which the debt is issued, and the tax treatment of periodic interest payments.
Companies (equity and debt) and governments (debt) try to issue equity and debt under conditions most favorable to themselves while, at the same time, they try to sate the appetites of investors so that equity and debt offerings are fully subscribed, in order to allow the company or government to raise the full amount of money required/sought.
One of the problems that many companies, governments and, ultimately, investors in the companies' and governments' equity and debt, encounter is that of short-selling, through which, investors and speculators borrow a company's or government's equity and/or debt from the owner or holder (fiduciary) and sell it in the market hoping to buy it back at a lower price and make a profit. Short-selling puts downward pressure on a company's shares and/or debt, or on a government's debt, which can have several harmful effects. First, as the price of a security falls, it can force long-term holders, who have been loyal to the company or government, to sell their securities to avoid a loss, which then adds to the selling pressure on a company's or government's securities and drives their price(s) lower. More importantly, as has been illustrated in this latest credit crisis, pressure from short-sellers can both raise the price to a company or government of raising capital via debt sales, and it can create excessive shareholder dilution when a company is forced to raise capital by selling more shares at lower prices.
However, short-selling has several functions. It allows investors with exposure to a company's equity and/or debt, and/or to a government's debt, to hedge their exposure by having an offsetting position in either the underlying equity or debt instrument or through a derivative instrument; in the event the hedge is in the form of a derivative instrument, the seller of that derivative instrument usually has to sell short a company's equity/debt or, if a government-based derivative, the government's debt, in order to hedge the derivative seller's downside exposure. Short-selling is also employed by speculators (hedge funds, bank trading desks, individuals, etc.) to make a direct bet against the underlying equity or debt of a company or government.
The advent of more sophisticated derivatives like credit default swaps (CDS's), levered exchange-traded funds (ETF's), and other exotic derivatives, along with the proliferation of hedge funds and other speculative interests, have combined to allow speculators and hedgers to put undue and intentional selling pressure on the equity and/or debt of a company or on the debt of government entities. A great example of this is the credit default swap market, which was started to allow lenders to hedge against the debt of companies to which they were lending. Today, the credit default swap market has underlying, issued debt totaling approximately $2 trillion, but the outstanding credit default swaps in existence total approximately $50 trillion.
An example of the unintended consequences of allowing investors, speculators and others to participate in these massively leveraged short sales is the collapse in 2008 of Bear Stearns, which was ultimately sold to JP Morgan Chase in a forced sale by the U.S. government. The Thursday before the weekend collapse of Bear Stearns, the CEO went on national television to proclaim that Bear Stearns had in excess of $17 billion of capital and that it would weather the growing financial crisis. However, massive short sales of the company's stock, combined with large buying of low-delta (out-of-the-money) put options and credit default swaps, made Bear Stearns appear to be on shaky financial ground. This, in turn, prompted those holding Bear Stearns' stock and debt to sell, which exerted additional downward pressure on the company's outstanding equity and debt. Customers of Bear Stearns, unnerved by the company's rapidly collapsing stock and bond issues, moved quickly to pull their funds on deposit with Bear Stearns, and the company quickly ran short of capital prompting government intervention. Without the use of large short sales and the aforementioned highly leveraged derivative instruments, which allowed speculators and others to cause massive selling of the underlying stock and bond issues as they were sold by the sellers of the derivatives instruments in order to hedge their exposures, Bear Stearns might have survived as an independent, ongoing entity.
Another problem caused by massive short-selling of a company's equity and/or debt, and of a government's debt, is that the further the prices of equity and/or debt are depressed by short-selling, the harder, more expensive, and more dilutive it becomes for a company or government to raise additional capital through additional debt or equity sales. Excessive selling pressure, via short sales and derivative instruments, on corporate or government debt, as has happened in this most recent financial crisis, can influence and/or cause rating agencies to downgrade a company's or government's financial ratings, thereby increasing the cost of raising additional capital via debt sales. Similarly, excessive downward pressure, via short sales and derivative instruments, on a company's stock can depress the stock to extremely low levels making additional equity sales highly dilutive to existing shareholders. In extreme cases, this pressure on a company's stock can make it virtually impossible to raise new capital via equity sales because of the dilutive effects.
Another problem associated with short-selling is that of naked short-selling, wherein a speculator or investor sells short a company's equity and/or debt or a government's debt without first sourcing the equity or debt to deliver against the short-sale. In naked short-selling, a speculator or investor sells short a company's equity or debt, or a government's debt, and then has a certain amount of time to find/borrow the shares or debt to deliver against the established short position. Naked short-selling, while illegal, is rarely prosecuted, as most of the time speculators and investors are able to find the equity or debt to deliver against their pre-established short position(s). Nevertheless, naked short-selling allows speculators to sell huge quantities of a company's equity or debt, or a government's debt, creating unnecessary downward price pressure on those instruments.
Securities lending is another business that fosters short-selling. “Securities lending is an over-the-counter market, so the size of this industry is difficult to estimate accurately. According to the industry group ISLA, in the year 2007, the balance of securities on loan exceeds $2 trillion globally.
The principal reason for borrowing a security is to cover a short position. Securities lending & borrowing is often required, by matter of law, to engage in short selling.” (Source Wikipedia)
Recently, there have been several attempts, all regulatory, to address the problems associated with and/or caused by short-selling. The Securities and Exchange Commission (SEC) imposed a temporary ban on short sales against financial institutions in an effort to ease the pressure on their equity and debt. The SEC also came out and reaffirmed the illegality of naked short sales. Various other remedies have been proposed, including: having hedge funds register with the SEC and reveal their positions; easing of mark-to-market accounting rules, which have exerted extreme valuation pressure on banks' balance sheets; further regulation of the CDS market (presently, there are several exchanges proposed that would better organize this market and require participants to post margin); and other proposed rules and regulations that all aim at imposing additional regulatory oversight in these various markets, on the various underlying equity, debt and their derivatives, and on speculators and investors that participate in these markets/instruments.
Many recent articles have highlighted the problems short-selling has created in the financial markets: “Naked Short Sales Provoke Complaints but No Cases” (The Wall Street Journal, Mar. 19, 2009), “One Way to Stop Bear Raids” (The Wall Street Journal, Mar. 24, 2009), “Global Stock Cops Look to Rein In Shorts” (The Wall Street Journal, Mar. 24, 2009), “Short Selling—New Idiom: March Came in Like a Bear” (The Wall Street Journal, Mar. 25, 2009), “Exchanges Try to Limit Shorts Ban” (The Wall Street Journal, Mar. 25, 2009), “‘Naked’ Ban Is Extended By Japan” (The Wall Street Journal, Mar. 25, 2009), “Have We Seen the Last of the Bear Raids” (The Wall Street Journal, Mar. 26, 2009) “Wrangling Ahead on Short-Sale Plans” (The Wall Street Journal, Apr. 9, 2009), “‘Empty Creditors’ and the Crisis” (The Wall Street Journal, (Apr. 10, 2009) to name a few of the most recent. However, as all of the articles make clear, short-selling is a very hard process to manage and regulate, as many speculators, investors and, even hedgers, are not required to report various positions across all equity, debt and derivative instruments. The use of leverage by market participants further exacerbates the negative effects of short-selling.
As illustrated above, short-selling has become a huge problem in today's capital markets, as it can increase a company's or government's borrowing costs and can cause excessive dilution via new equity issuance. It also can increase volatility in a company's or government's securities, which can force longer-term security holders to sell their securities to avoid a loss. Every proposal to address the problems associated with short-selling, to date, has been regulatory in nature. What is needed is a market-based solution that allows security issuers to manage short-selling in their securities.
Also known in the prior art is the ability of market practitioners to unbundle various sets of rights associated with issued securities in order to derive added benefit from the individual rights associated with issued securities (equity and debt). As an example, a hedge fund may purchase a large block of stock in a company in order to exercise the voting rights associated with those shares for/against management's proposals and, at the same time, buy downside derivative protection in the form of equity put options (or other equity derivatives) on those shares to hedge against any downside move in the stock. This strategy has effectively allowed the hedge fund to gain control of a voting interest (voting rights) in the company without economic exposure should the stock it is holding move lower (in fact, the hedge fund can gain the voting interest (voting rights) and profit if the stock moves lower via this arrangement).
Similarly, an investor may hold an equity or debt security and pledge the income stream (right to dividend payments (equity) or right coupon payments (debt)) toward a charity, educational entity or trust. Effectively, the investor has unbundled an equity or debt right from the sets of rights that accompany issued equity and/or debt.
U.S. Publication No. 20050125323 to Warren, U.S. Publication No. 20020198833 to Wohlstadter, U.S. Publication No. 20050080705 to Chaganti, and U.S. Pat. No. 7,310,616 to Sugahara all disclose various methods for recognizing and trading various security rights of issued securities. However, each of these prior art references fail to address, either singularly or in combination with each other, the aforementioned problems associated with short-selling of a company's (equity and debt) or a government's (debt) securities, as each still allows a company's or government's issued securities to be shorted—a process over which, the company or government has no control. And, as demonstrated in the aforementioned hedge fund voting right example, it is possible for an investor/speculator to use and manipulate individual security rights to the detriment of the issuing company, government, or other entity.
In view of all of the aforementioned shortcomings, deficiencies and inefficiencies that exist in financial marketplaces, there is a great need in the art for improved systems and methods for solving the problem(s) associated with investors, speculators and/or hedgers putting unwarranted downward pressure on the prices of companies' and governments' equity and debt instruments through short sales and the use of derivative instruments, while avoiding the shortcomings and drawbacks of the prior art apparatus and methodologies heretofore known.